Tests in investments, Financial Management

Tests in Investments

There are many rules that specify how the past data of share prices can be used to obtain a clue regarding the future prices of shares. Such rules would be valuable to an investor because they could be used to determine which share prices are likely to rise. Hence the investor could buy such share and sell them in future at a higher price thereby earning a profit.

Statistical tests have been applied to examine whether such rules can deliver what they promise. Can investors using these rules earn higher profits than investors not using these rules? Do these rules really provide clues about the future prices of shares? Are short-term share price fluctuations not random in nature? Below are the results of two tests applied to past data of share prices to ascertain whether such data has any information relevant to future share price estimates.

Serial Correlation Tests

We have studied correlation applied to pairs of observations. For example, we can find out the correlation of one share price with another share's price, or the correlation of one company's share price with the company's profits.

In auto-correlation we ascertain the correlation of current observations in a set with past observations of the same set. As applied to investments, serial correlation has been used to find the correlation coefficient between current changes in a share's price and past changes in the same share's price. It was found that the correlation coefficient was very near to zero. If current share price changes are uncorrelated with past share price changes, how can the rules based on a study of past share prices have any predictive value?

Runs Tests

Correlation coefficients are unduly influenced by extreme observations. It was argued that a few unrepresentative extreme observations may have distorted the results of the above Serial Correlation Tests. So Runs Tests were devised. Here, only the directions of share price changes were considered. As the magnitudes of price changes were ignored, the excessive influence of extreme observations was removed.

In a typical Runs Test the changes in share prices may be classified as '+' meaning an increase and '-' meaning a decrease. A run is said to last as long as the price changes do not change direction. For example, given the following daily price changes of a share, we can identify three runs.

1249_runs test.png

So Runs Tests also appear to support the conclusion that share price changes are random.Runs Tests reveal that the number of runs are nearly equal to the runs that would be expected if share price changes were random.

Posted Date: 9/17/2012 2:01:31 AM | Location : United States







Related Discussions:- Tests in investments, Assignment Help, Ask Question on Tests in investments, Get Answer, Expert's Help, Tests in investments Discussions

Write discussion on Tests in investments
Your posts are moderated
Related Questions
Q. What are the Benefits of Holding Inventories? (1) Timing of Demand and Supply: - Requirement to hold inventory of raw materials arises because it isn't possible for a firm

Criticism of Profit Maximization Approach: (i) Ambiguous: - One practical complexity with this approach is that the term profit is ambiguous. Different people take dissimilar me

What is Sinking Fund A provision which requires the corporation to set aside a fixed amount every year to help provide for orderly repayment of the debt issue.

Purpose of research: The aims of this research are to examine the effectiveness of speculation on efficiency of Petrochemical sector in Saudi Arabia financial market"TADAWUL".

Traditional   Capital Budgeting Techniques These techniques are usually very simple and easily catchable. But the fundamental drawback of these methods is that they don't cons

Linear programming, one of the important techniques of operations research, has been applied to a wide range of business problems. This techniqu

Present V alue This is the current value of a future payment or stream of payments. The present value is calculated by applying a discount (capitalization) rate to the

Q. What do you mean by synergy? Synergy: synergy refers to the greater combined value of merged firms than the sum of the values of individual units. It is something like one p

What are the main flaws of the profit maximisation criterion The main technical flaws of this criterion are i) ambiguity, ii) quality of benefits and iii) timing of be

Net Present Value (NPV) : In this technique, future cash flows are discounted to the present and then compared with the investment outlay. The basic discount rate is generally